Tax Cuts and Jobs Act Extends Benefits of 529 Plans
By Matt Quinn, CFA® April 2018
How to get the most out of saving for education-related expenses
According to The College Board’s 2017 Trends in College Pricing, average published rates for tuition and fees increased by more than 3% in 2017 at both private and public four-year colleges. That is well above the general rate of inflation in the U.S. and the 2.4% year over year increase in average hourly earnings as reported by the U.S. Bureau of Labor Statistics. Tuition and fees also grew at a faster rate than the average for the last decade. That growth puts the average annual estimated full-time undergraduate budget at $50,900 for a private college and roughly half that amount for an in-state undergraduate degree at a public institution. Based on a recent survey conducted by Student Loan Hero, nearly 80% of parents haven’t even saved enough for one year’s worth of higher learning let alone the full four years.The good news is that recent tax law changes maintain the benefits associated with utilizing a 529 plan to save for college education-related costs. Depending on your state of residence, contributing to a 529 plan may be a great solution for keeping state and local taxes (SALT) below the $10,000 deduction limit that will be imposed for Federal Tax Reporting in 2018. However, did you know that the Tax Cuts and Jobs Act also extends the definition of qualified education expenses to include the costs of K-12 education? Up to $10,000 a year can now be withdrawn from these plans to cover these primary and secondary education-related costs.Named for Section 529 of the federal tax code, a 529 plan is a tax-advantaged savings plan designed to encourage saving for anticipated education-related costs. The plans are offered in all 50 states and can be established by any individual for a designated beneficiary. Plan contributions and earnings on those contributions can be withdrawn without federal taxes or penalties if they are used to pay for qualified education-related expenses, including tuition at primary, secondary, and post-secondary institutions as well as the cost of books, supplies, and room and board for college students living away from home. The designated beneficiary can also be modified if their circumstances change.
What should you do?
Do some research into the 529 plan offered in your state. A good place to start would be Morningstar, which ranks 34 plans as best in class options. They rank 529 plans based on their five key pillars - people, process, parent, price and performance. This helps to at least set the stage for those plans that are following the industry’s best practices. Being analytical types, we recommend never relying just on a rating from any company or agency, but it does provide a base level of comfort that the plan is at least set up correctly.If you are a resident of a state with state income tax, the tax implications of saving in the plan are more than likely going to be the primary driver of a decision. Some states such as Pennsylvania don’t care where the 529 plan is held and are willing to give a deduction to residents based on their contributions. Other states specify that you must own the 529 plan in the state of your residence to qualify for the tax deduction. For example, Illinois offers a $10,000 state income tax deduction for contributions made into the Illinois 529 plans ($20,000 for taxpayers filing jointly). However, this is subject to recapture in the event the account holder takes a nonqualified withdrawal or rolls the account into a non-Illinois 529 plan. For residents of the state of Illinois, the benefits and potential penalties associated with moving the plan assets to another state are clear.The good news is that anyone can open or contribute to a 529 plan and contributions can be made in a variety of ways. Most plans are now offered directly and not sold through brokers or other financial intermediaries. Typically, plans allow for either one-time deposits or recurring deposits from payroll deductions or bank accounts. Most plans also have some way to invite family and friends to contribute. What a wonderful way for a new grandparent to secure the educational future of a grandchild! Those that are more tech savvy can even set up recurring distributions and receive electronic communications directly from the plan.If you have further questions or would like to talk through funding or investment strategies for 529 plans, we would love to start a conversation!